Fundamentals of

Accounting
Accounting in Action
Accounting Activities and Users
• Accounting consists of three basic activities—it
identifies, records, and communicates the economic
events of an organization to interested users.
Accounting
Activities
Identify

“What economic activities are

relevant to the business?”
Identify
Identify which economic
events are relevant to
the business.
 Record
Accounting “What is the history of the financial
activity?”
Activities
Kitchen
Equipment
Chef’s wage /
Salary
Furniture
Accounting
Activities
Communicate

“What do the financial data

mean?”
Accounting
Activities
Communicate

“What do the financial data

mean?”
The Accounting Process
Users of Accounting
Data
Users of
Accounting
Data
• Users of accounting
information can be
divided broadly into
two groups: internal
users and external
users.
Financial vs
Managerial
Accounting
Internal users
• Internal users of accounting
information are the managers who
plan, organize, and run a business
 External users
External users are individuals and organizations outside a company
who want financial information about the company
Internal or
External User
True or False
• The three steps in the accounting process are
identification, recording, and communication.
• Bookkeeping encompasses all steps in the accounting
process.
• Accountants prepare, but do not interpret, financial
reports.
• The two most common types of external users are
investors and company officers.
• Managerial accounting activities focus on reports for
internal users
Accounting in Action
The Building Blocks of
Accounting
Building
Blocks

• Ethics
• Principles
• Assumptions
Ethics in
Financial
Reporting
• The standards of conduct
by which actions are
judged as right or wrong,
honest or dishonest, fair
or not fair, are ethics.
Ethics in Financial Reporting
Principles

• Generally Accepted
Accounting Principles
• International Financial
Reporting Standards
Measurement
Principles

• Relevance
• Faithful Representation
Measurement
Principles

• Historical Cost Principle

• Fair Value Principle
Historical
Cost
Historical Cost
Historical Cost
Historical Cost
Assumptions

• Monetary Unit Assumption

• Economic Entity
Assumption
 • The monetary unit assumption requires that companies
Monetary include in the accounting records only transaction data that
can be expressed in money terms.
Unit • This assumption enables accounting to quantify
(measure) economic events.
Assumption • The monetary unit assumption is vital to applying the
historical cost principle.
Economic
Entity
Assumpti
on
• The economic entity assumption requires that
the activities of the entity be kept separate
and distinct from the activities of its owner
and all other economic entities.
The Accounting Equation
Assets
• The business uses its assets in carrying out such
activities as production and sales.
• The common characteristic possessed by all assets is
the capacity to provide future services or benefits.
• In a business, that service potential or future economic
benefit eventually results in cash inflows (receipts).
Liabilities
• Liabilities are creditor claims against total assets—that
is, existing debts and obligations. Businesses of all sizes
usually borrow money and purchase merchandise on
credit.
Owner’s Equity
• The ownership claim on total assets is owner’s equity.
• It is equal to total assets minus total liabilities.
Owner’s Equity
• The assets of a business are claimed by either creditors
or owners.
• To find out what belongs to owners, we subtract the
creditors’ claims (the liabilities) from assets.
• The remainder is the owner’s claim on the assets—the
owner’s equity.
The Recording Process
Accounts, Debits, and Credits
• An account is an individual accounting record of increases and
decreases in a specific asset, liability, or owner’s equity item.
• The term debit indicates the left side of an account, and credit indicates
the right side.
Accounts, Debits, and Credits
• In its simplest form, an account consists of three parts:
• 1. A title.
• 2. A left or debit side.
• 3. A right or credit side
Accounts
Debits and Credits
• The term debit indicates the left side of an account, and credit indicates
the right side.
• Sometimes abbreviations are used: Dr. for debit and Cr. for credit.
• They do not mean increase or decrease, as is commonly thought.
• We use the terms debit and credit repeatedly in the recording
process to describe where entries are made in accounts.
Debits and Credits
The T-Account
• Having increases on one side and decreases on the
other reduces recording errors.
• The T-­account form helps in determining the totals of
each side of the account as well as the account balance.
• The balance is determined by netting the two sides
(subtracting one amount from the other).
Debit and
• Debits must equal credits.
• The equality of debits and credits

Credit
provides the basis for the double-entry
system of recording transactions.

Procedur
• Under the double-­entry system, the dual
(two-­sided) effect of each transaction is
recorded in appropriate accounts. This
e system provides a logical method for
recording transactions.
Dr./Cr. • Both sides of the basic equation (Assets

Procedur
= Liabilities + Owner’s Equity) must be
equal.

es for
• It therefore follows that increases and
decreases in liabilities have to be
recorded opposite from increases and
Assets decreases in assets.
• Thus, increases in liabilities are entered
and on the right or credit side, and decreases
in liabilities are entered on the left or

Liabilities
debit side
Dr./Cr. Procedures for
Assets and Liabilities
Dr./Cr. Procedures for Owner’s
Equity
• Investments by owners are credited to the Owner’s Capital account.
• Credits increase this account, and debits decrease it.
• When an owner invests cash in the business, the company debits
(increases) Cash and credits (increases) Owner’s Capital.
• When the owner’s investment in the business is reduced, Owner’s
Capital is debited (decreased)
Dr./Cr. Procedures for
Owner’s Equity
Dr./Cr. Procedures for Owner’s
Drawings
• An owner may withdraw cash or other assets for personal use.
• Withdrawals could be debited directly to Owner’s Capital to indicate a
decrease in owner’s equity. However, it is preferable to use a separate
account, called Owner’s Drawings.
• Owner’s Drawings is increased by debits and decreased by credits.
• Normally, the drawings account will have a debit balance.
Dr./Cr. Procedures for
Owner’s Equity
Dr./Cr. Procedures for Revenue and
Expenses
• When a company recognizes revenues, owner’s equity increases.
• Credits increase revenue accounts and debits decrease them.
• Therefore, the effect of debits and credits on revenue accounts is
the same as their effect on Owner’s Capital.
• Expenses decrease owner’s equity.
• Thus, expense accounts are increased by debits and decreased by
credits.
 Dr./Cr. Procedures for
Revenue and Expenses
Accounts, Debits, and Credits
Identify the normal balance

CASH SUPPLIES NOTES EQUIPMEN ACCOUNTS OWNERS’

PAYABLES T PAYABLE CAPITAL
The Recording Process - The Journal
The Recording Process

ANALYZE: ­ANALYZE­EACH­ JOURNALIZE: ­ENTER ­THE ­ POST:­TRANSFER­THE ­JOURNAL­

TRANSACTION ­FOR ­ITS ­EFFECT ­ TRANSACTION ­INFORMATION ­IN ­ INFORMATION­TO ­THE­
ON­THE ­ACCOUNTS. A ­JOURNAL. APPROPRIATE ­ACCOUNTS IN ­
THE ­LEDGER.
 • The journal is referred to as the book of
original entry.
• For each transaction, the journal shows
the debit and credit effects on specific
accounts.
The • Companies may use various kinds of
journals, but every company has the
Journal most basic form of journal, a general
journal.
• Typically, a general journal has spaces
for dates, account titles and
explanations, references, and two
amount columns.
 • It discloses in one place the complete
effects of a transaction.
The • It provides a chronological record of
transactions.
Journal • It helps to prevent or locate errors
because the debit and credit amounts for
each entry can be easily compared
Journalizi
• The date of the transaction.
• The accounts and amounts to be debited

ng
and credited.
• A brief explanation of the transaction
Journalizing
Journalizing
• It is important to use correct and specific account titles in journalizing.
• Erroneous account titles lead to incorrect financial statements.
However, some flexibility exists initially in selecting account titles.
• The main criterion is that each title must appropriately describe the
content of the account.
• Once a company chooses the specific title to use, it should record
under that account title all later transactions involving the account
Journalizing – An illustration
Do it!
• Kate Browne engaged in the following activities in
establishing her salon, Hair It Is:
1. Opened a bank account in the name of Hair It Is, and
deposited $20,000 of her own money in this account as her
initial investment.
2. Purchased equipment on account (to be paid in 30 days) for
a total cost of $4,800.
3. Interviewed three people for the position of hair stylist.

Prepare the journal entries to record the transactions

The Recording Process - The Ledger
and Posting
The Ledger
• The ­ledger ­provides­the­
balance ­in ­each ­of ­the­
accounts­as ­well as ­keeps­
track ­of ­changes in­these ­
balances.
• Companies ­may ­use ­various ­
kinds ­of ­ledgers,­but ­every­
company has­a­general ­ledger.
• A ­general ledger ­contains­all ­
the­asset,­liability, ­and­owner’s
equity ­accounts.
Standard Form of Account
 • The procedure of transferring journal
entries to the ledger accounts is called

Posting posting.
• This phase of the recording process
accumulates the effects of journalized
transactions into the individual accounts.
Posting - Steps
• In the ledger, in the appropriate columns of the account(s) debited,
enter the date, journal page, and debit amount shown in the journal.
• In the reference column of the journal, write the account number to
which the debit amount was posted.
• In the ledger, in the appropriate columns of the account(s) credited,
enter the date, journal page, and credit amount shown in the journal.
• In the reference column of the journal, write the account number to
which the credit amount was posted.
Remember
• Posting should be performed in chronological order. That is, the
company should post all the debits and credits of one journal
entry before proceeding to the next journal entry.
• Postings should be made on a timely basis to ensure that the
ledger is up-­to-­date.
• The reference column of a ledger account indicates the journal
page from which the transaction was posted.(After the last entry
has been posted, the accountant should scan the reference
column in the journal, to confirm that all postings have been
made.)
• The explanation space of the ledger account is used infrequently
because an explanation already appears in the journal.
 • This chart lists the accounts and the
account numbers that identify their
Chart of location in the ledger.
• The numbering system that identifies the
Accounts accounts usually starts with the balance
sheet accounts and follows with the
income statement accounts.
Chart of Accounts
The Recording Process Illustrated
The Recording Process Illustrated
The Recording Process Illustrated
The Recording Process Illustrated
Do it!
• On October 1, Pioneer purchases ofce equipment
costing $5,000 by signing a 3-month, 12%, $5,000 note
payable.
• On October 2, Pioneer receives a $1,200 cash advance
from R. Knox, a client, for advertising services that are
expected to be completed by December 31.
• On October 3, Pioneer pays ofce rent for October in
cash, $900.
• On October 4, Pioneer pays $600 for a one-year
insurance policy that will expire next year on September
30
Do it!
• On October 5, Pioneer purchases an estimated 3-month
supply of advertising materials on account from Aero
Supply for $2,500.
• On October 9, Pioneer hires four employees to begin
work on October 15. Each employee is to receive a
weekly salary of $500 for a 5-day work week, payable
every 2 weeks—first payment made on October 26.
• On October 20, Pioneer receives $10,000 in cash from
Copa Company for advertising services performed in
October.
Do it!
• On October 26, Pioneer, owes employee salaries of
$4,000 Payment of salaries and pays them in cash.
• On October 31, C. R. Byrd withdraws $500 cash for
personal use.
The Recording Process - The Trial
Balace
 • A trial balance is a list of accounts and
their balances at a given time.
• Companies ­usually ­prepare­a ­trial­
balance ­at ­the­end­of ­an accounting ­
The Trial period.
• They­list­accounts­in ­the ­order­in ­
Balance which ­they ­appear­in­the­ledger.
• Debit ­balances­appear­in­the­left ­
column­and­credit ­balances­in­the
right ­column.­The totals ­of ­the ­two ­
columns ­must­be ­equal.
Preparing • List­the ­account ­titles ­and­their ­balances ­
in ­the ­appropriate ­debit or ­credit column.
the Trial • Total­the­debit ­and­credit ­columns.

Balance • Verify ­the ­equality ­of ­the ­two­columns.

Limitatio • A transaction is not journalized.
• A correct journal entry is not posted.
ns of a • A journal entry is posted twice.

Trial
• Incorrect accounts are used in
journalizing or posting.
• Offsetting errors are made in recording
Balance the amount of a transaction
Locating Errors
• Errors in a trial balance generally result from mathematical mistakes,
incorrect postings, or simply transcribing data incorrectly.
Locating Errors – Useful steps
• First, determine the amount of the difference
between the two columns of the trial balance.
• Useful steps to take:
• 1. If the error is $1, $10, $100, or $1,000, re-­add
the trial balance columns and recompute the
account balances.
• 2. If the error is divisible by 2, scan the trial
balance to see whether a balance equal to half
the error has been entered in the wrong column.
Locating Errors – Useful steps
• 3. If the error is divisible by 9, retrace the account
balances on the trial balance to see whether they
are incorrectly copied from the ledger.
• For example, if a balance was $12 and it was listed as $21, a
$9 error has been made. Reversing the order of numbers is
called a transposition error.
• 4. If the error is not divisible by 2 or 9, scan the
ledger to see whether an account balance in the
amount of the error has been omitted from the trial
balance, and scan the journal to see whether a
posting of that amount has bee
Do it!
The Recording Process